Summary
- The banking industry scored a return on equity of 11.67 percent, has lots of cash on hand, and seems to be lending quite freely.
- The Federal Reserve is tightening up its monetary policy and looks like it will keep things tight for an extended period of time.
- But, the environment is a "new" one, with both the Fed and the banks operating in unknown territory.
- Should be an interesting year in the financial markets.
The year 2022 was quite a year for the banking industry.
For the industry, the return on equity came out to be 11.67 percent. In the year 2018, the ROE was greater than this number, but not by much, and then one has to go back a long time before this number was reached.
In 2020 and 2021, the return on equity for the banking system was 12.21 percent and 12.66 percent, respectively.
The Pandemic years have been good years for the banking industry.
Bank profits: records for the last two years.
What is truly remarkable is the amount of cash and very liquid assets the banking system has on hand.
At the end of December 2022, commercial banks had something like $3.1 trillion in cash on hand. At the end of 2021, the cash on hand was around $4.0 trillion. And, at the end of 2020, commercial banks had $3.2 trillion cash on hand.
I have written frequently about one of the problems the Federal Reserve faces in attempting to tighten up on monetary policy, and that is the fact that the banking system has so much cash on hand.
How can the Fed really "tighten up" on monetary policy with so much "free cash" hanging around?
That is a very real issue for the Fed.
Banks Don't Need Cash
The point is that banks don't need to get cash to make loans.
This can be seen in the net interest margin the banks are earning on their loans.
The net interest margin in the banking system was 2.95 percent in 2022, up from 2.54 in the preceding year.
The banking system lost deposits, but, then again, the deposits were not really needed given the cash assets the banks had on hand.
(Note: One can see from the following chart the buildup of deposits during the early stage of the Covid-19 pandemic.)
Even with the decline in bank deposits, the banks were lending money.
For example, the banks made $12.2 trillion in total loans and leases in 2022, which was up 9.0 percent from one year earlier.
Loan loss provisions?
Well, preparing for a recession, the banks allocated $51.6 billion to their loan loss reserves in 2022.
Note that in 2021, the banks actually removed about $31.0 billion from their loan loss provision.
However, even the $51.6 billion provision for loan losses in 2022 does not look overly aggressive, given the other information on the chart.
Looking Forward To 2023
It is almost confusing to look at all these data.
The Federal Reserve has been tightening up on monetary policy for the past year.
Fed chair Jerome Powell and the Fed Board seem to be intent on carrying on this monetary tightening for an extended time into the future.
It's just that the banks don't seem to be "squeezed," by any extent of the word.
In fact, if anything, the banking system seems to have a plentiful amount of funds on hand.
The banks are allocating funds to loan loss reserves..."just as a precaution"...but, look at the figures.
The whole banking system earned a return of 11.67 percent on its equity.
In the banking industry, this is well over commercial banks' cost of capital.
And, in the previous two years, the ROE was well in excess of 12.0 percent!
These are not the usual conditions of the U.S. banking system as it prepares to go into an economic recession.
These are strange times. Nothing is like "it used to be."
And, the Federal Reserve is acting in a different way. (You can read my recent work on this, discussing the Fed's policy efforts called "quantitative tightening."
So, it is going to be an interesting ride.
For further details see:
Bank Profits, Bank Cash: No Failures